Bank rate cuts not a quick fix
Emergency interest rate cuts Wednesday by the Federal Reserve and five other central banks left in doubt whether government efforts to cure the financial crisis would show results fast enough to avert fresh panic and serious economic damage.
The synchronized actions failed to inspire stock investors. The Dow Jones industrial average fell 189 points, or 2%, its sixth straight daily decline. European markets fared much worse, with most stock indexes plunging 5% to 7%. There were only hints of improvement in the credit markets.
U.S. Treasury Secretary Henry M. Paulson acknowledged that the financial system’s problems could last for some time.
“I think it’s too early to look for encouraging signs in the credit markets,” he told reporters. “It’s going to take awhile to work through this problem.”
The reduction in the Fed’s benchmark rate by half a percentage point to 1.5% was just the latest in a series of extraordinary steps by the central bank and the Treasury Department to restore confidence to investors and banks.
The move came five days after the enactment of a $700-billion program to buy up toxic mortgage securities and just one day after the Fed said it would supply vital credit directly to businesses by spending potentially hundreds of billions of dollars to buy short-term corporate debt.
But both of those efforts are still in the implementation stage, and it will be weeks at best, officials say, before the wheels actually begin to turn.
Meanwhile, a housing rescue program passed by Congress over the summer to refinance the loans of troubled homeowners with safer mortgages took effect just this month. A major proponent of that program, Rep. Barney Frank (D-Mass.), demanded Wednesday that major mortgage lenders and servicers voluntarily refinance more of the bad mortgages on their books.
And although rate cuts normally cheer markets instantaneously and spur lending quickly, Wednesday’s actions might not have the desired result if banks remain afraid to lend. And even if lower rates do in fact boost the availability of credit, it can take many months for the effects to work their way through the economy.
Nonetheless, the central banks “have to try everything they can at this point in the crisis,” said Nigel Gault, chief U.S. economist at forecasting firm Global Insight in Lexington, Mass. “Rate cuts are not a cure-all, but you have to do it. And it’s important that this is done globally because this is a global crisis.”
But investors are in no mood to wait for the financial medicine to do its job, said David M. Jones, a former Fed economist and president of DMJ Advisors, a Denver-based consulting firm.
“What you need in this situation is patience because it takes at least a year for markets like this to recover. But the last thing a stock market gripped by fear has is patience,” Jones said.
The result is that fearful investors are devaluing stocks even of healthy, solvent companies. That raises the risk that consumers, facing steep declines in their stock portfolios, will cut back on spending, slowing the economy further.
In essence, the global economy is dealing with two financial contagions, said David Moss, who teaches economic history at Harvard University.
“If you look at the Depression, it started with a stock crisis and it took awhile for the credit crisis to begin,” Moss said. “We’re having them simultaneously, which I think is a bad twist.
“But the good news is that we have an extraordinarily aggressive Treasury and set of central banks and they are working very hard,” he said.
In a fresh sign of economic weakness, major retailers that reported preliminary sales data for September showed declines that foreshadow a dismal holiday shopping season.
“This entire financial crisis has really spooked a lot of consumers,” said Ken Perkins, president of research company Retail Metrics Inc. “They’re feeling it on virtually every front that they can feel it on: job security, food-price inflation, gas prices.”
Also Wednesday, in a move further extending the government’s intervention in the financial system, the Fed announced that it would pump as much as $37.8 billion more into American International Group Inc., the insurance giant that was saved from bankruptcy proceedings last month by an $85-billion government bailout.
In the stock market, the expiration of another unprecedented government action could lead to more instability today: A temporary ban on the “short selling” of financial stocks was to expire overnight. The ban was put in place last month to protect financial institutions from the effects of a plunging stock price. Short sellers use a trading technique designed to profit from a decline in a stock’s price.
Gary Schlossberg, senior economist for Wells Capital Management in San Francisco, said the government’s $700-billion rescue would deal with the root cause of the credit squeeze: the lack of a market for mortgage-backed securities.
Once the Treasury Department starts buying that debt, the stock market could have a “very strong bounce back,” he said.
But until then, the ride looks to be rough.
“Things could get a whole lot worse before they could get better,” Schlossberg said. “Right now I’d say the markets have overreacted, but they always do.”
Times staff writers Walter Hamilton in New York and Andrea Chang in Los Angeles contributed to this report.